Question

If the economy is in equilibrium at a level above its potential GDP level, it is experiencing:

Select one:

a. an inflationary (expansionary) gap.

b. a supply shock.

c. a recessionary (contractionary) gap.

d. a productivity expansion.

Answer 1

Answer- Correct option is 'a'

If the economy is in equilibrium at a level above its potential GDP level, it is experiencing an inflationary (expansionary) gap. An economy that operates above its full employment equilibrium means it produces goods and services at a higher rate than its potential or long run average levels as measured by its GDP. This is a situation of inflationary gap, because the relative increase in real GDP cause an economy to increase its consumption, which cause price to rise in long run. When the real GDP is higher than the potential GDP is, the gap is referred to as a inflationary gap.